Debt Mutual Fund schemes are better options to traditional savings in the light of current high interest rates

Debt funds invest in government securities, fixed income securities issued by highly rated companies and money market instruments. These are the same investments that banks invest your deposits in, except that banks have higher operating costs that reduce the interest that they can pay on your deposits.

If you own a business, you may be using the current account for your chequeing needs and the short-term fixed deposit for short-term money deposits. For these needs, a debt fund offers you what is called a “Cash Fund” as an alternative to your current account and what is called a “Short-Term Plan” as an alternative to a short-term fixed deposit of 90 days. Again each of these debt funds invests in the same type of instruments that your bank invests in. Of course, if you save in a short-term fixed deposit, the money would be compulsorily returned to you after the deposit term ends while with the short-term plan of the debt fund you have no such problem as you can invest or withdraw based on the Net Asset Value on any working day.

A savings account may be the one you use most often if you are a salaried employee or a housewife or a student. You may also be using a recurring deposit to accumulate savings by investing small amounts every month. The same short-term plans of debt funds explained above can be used for depositing your salary or small savings, and they will give you the ability to earn higher returns than your savings account. If you have chosen the wise option of accumulating savings every month, plans called Systematic Investment Plans (SIP’s) are offered by most debt funds as an alternative to recurring deposits.

All these debt funds also come with the advantage of not having a specified tenure. This saves you the hassle of reinvesting after the term is over and the pain of losing interest if you break the fixed deposit before its term. An example will clarify this.
Mr. Sharma and Mr. Verma who have just received a bonus, want to save it for a year. While
Mr. Sharma invests his bonus in a 1-year fixed deposit, Mr. Verma invests in a medium-term debt fund. Now, 9 months after this, suddenly a very attractive deal is available on a second-hand car, but the seller wants cash. Mr. Sharma worries about the fact that breaking his fixed deposit will make him lose his returns and dithers, while Mr. Verma seals the deal with the seller and fills out his redemption request slip for his medium-term mutual fund plan. In a matter of a three working days, his debt fund investment has been deposited back into his savings account. He immediately withdraws the cash and settles the payment for the car - all this without any worry of losing the returns he has accumulated for 9 months.

The other important benefit is that while fixed deposits give no tax benefits, dividends on debt funds are tax-free in the hands of the investor, with the company paying a 14.16% dividend distribution tax. If held for more than a year a debt fund investment in fact attracts only 10% long term capital gain tax.

Current accounts, savings accounts, recurring deposits, short, medium and long-term fixed deposits, each have a corresponding alternative offered by a range of debt funds. The benefits in each case are similar: viz. ease and quickness of withdrawal, tax friendliness and possibility of higher returns.

To understand the process of investment, lets return to Mr. Sharma. After missing out on the car, he decides to invest the amount he receives from his fixed deposit into a debt fund. He simply fills in an application form collected from BrainPoint Investment Centre and fills it in, attaches the cheque for the amount to be invested and returns it for processing. He receives a statement confirming his investment and is given his folio number within three days.

As you see investment and withdrawal in debt funds is a quick and easy process. Also for a start, you can actually invest as little as five hundred rupees in a debt fund to begin with and become comfortable with the process before investing larger amounts. As they say, the proof of the pudding is in the eating. The recipe described above is surely the one to give you sweet returns.